THE financial regulator is cracking down on interest-only mortgages in a bid to rein in soaring house prices.

The Australian Prudential Regulation Authority wrote to the banks today to announce new measures to “reinforce sound residential mortgage lending practices in an environment of heightened risks”.

Under the new rules, banks must limit the flow of interest-only loans to 30 per cent of total new residential mortgages, and within that, place “strict internal limits” on the volume of interest-only loans at loan-to-value ratios above 80 per cent.

They will also have to “ensure there is strong scrutiny and justification” for any interest-only lending at an LVR above 90 per cent.

“APRA views a higher proportion of interest-only lending in the current environment to be indicative of a higher risk profile,” ARPA chairman Wayne Byres said.

“We will therefore be monitoring the share of interest-only lending within total new mortgage lending for each ADI [authorised deposit-taking institution], and will consider the need to impose additional requirements on an ADI when the proportion of new lending on interest-only terms exceeds 30 per cent of total new mortgage lending.”

He said the regulator had chosen not to put a figure on serviceability assessments “at this point in time”. “However, APRA considers it important that borrowers retain some level of financial buffer to allow for unexpected events, especially for borrowers that have high levels of indebtedness,” he said.

“APRA will therefore continue to scrutinise serviceability assessments, and ADIs continue to need to advise APRA should they propose to change their existing methodologies or policies.”

It comes after the regulator introduced a 10 per cent growth cap for investor loans, which APRA says “continues to provide an appropriate constraint in the current environment”.

Mr Byres said APRA “expects ADIs to target a level of investor lending growth that allows them to comfortably manage normal monthly volatility in lending flows without exceeding this benchmark level”.

APRA said the new measures were aimed at “improving the quality of new mortgage lending generally and moderating the growth of investor lending in particular”.

“Since December 2014, APRA, together with CFR [Council of Financial Regulators] members, has closely monitored residential mortgage lending trends and the resulting impacts on the resilience of lenders, as well as the household sector more broadly,” it said.

“This increased scrutiny has been in response to an environment of heightened risks, reflected in an environment of high housing prices, high and rising household indebtedness, subdued household income growth, historically low interest rates, and strong competitive pressures.”

Earlier this week, LF Economics founder Lindsay David called for interest-only mortgages to be banned altogether, describing them as “dangerous to the core fundamentals of the Australian economy” and “toxic” to the housing market.

Mr David said the new cap introduced by ARPA was “about as watered down as it could possibly get”, and reiterated his call for interest-only loans to be banned.